Friday, February 4, 2011

The Effects of Qualitative Easing

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I hadn't decided what this post should be about as I watched Mr. Bernanke say he did not feel rising commodity prices were being caused by U.S. monetary policy. His take is higher prices result from too much growth in the developing countries. He did admit that Qualitative Easing Round 2 was causing fixed income investors to look to "alternative" investments since yields were historically low. (Just not commodities, I suppose).

Then came the story that commodity traders were making a huge bet on Thursday against base materials - copper, lead, etc..

Then I remembered a recent conversation I had regarding when the U.S. might have to ease up on what they are doing before riots the likes of Egypt started breaking out all over the place.

My point is, whenever the government starts to mess with the markets, it always, always, always, ends badly. Do they not remember the cause of the financial crisis the world is, even now, trying to recover from? As a kid, I think the expression was, "Two wrongs never make a right!"

I blogged a few days ago how I don't believe in forecasts, so while I cannot predict with any accuracy when it will happen, we can know from history that it will happen. The chart above shows us the CRB Index. It is an index which reflects the movement of global commodity prices. The green lines I have drawn on the chart reflect the normal retracement levels for a typical correction. Like dropping a golf ball, or a basketball, or any rubber ball, the bounce is somewhat predictable. Does that mean the index can't go higher than the highest green line? No, but probability says that it normally won't. You can see why traders are preparing for a reversal in commodity prices.

There are a couple of reasons why that might not happen. First, the government stimulus may not have run its course, as yet. Mr. Bernanke did not rule out the possibility of QE3 in his presentation. Personally, I don't think they know what else to do. Secondly, we are in the middle of the period of time when materials, metals, and mining tend to do their seasonal best. The third reason would be what I said about things ending badly. We are close to the point when we would expect a reversal. The longer the prices run up, the worse the result, both to the world economy, and to the eventual crash.

I can hear it all now. Once QEn (where n equals infinity) no longer has a stimulative effect and things come crashing down around our ears, the best and brightest minds(?) on the planet will tell the cameras with completely straight faces, that despite riots in the streets protesting the unaffordability of food and fuel, nobody knew a crash might happen! Sound familiar?

I'm not trying to scare anyone out of the market, but I am suggesting a great deal of caution out there!

About Me

A self-styled buyer/seller of equities on the Toronto Stock Exchange, I have since retired from having to work for others and am currently pursuing charitable interests.

Twenty years ago I realized there were not nearly enough hours in the day for me to earn my way to financial freedom. The alternative, as I saw it, was to build my wealth by putting it to work earning the best returns possible. Even after what would be almost 20 years working in the financial services industry, I remained unprepared for what that would mean.

Today, after starting my own investing club, my goal is to teach others what I have learned during my time working in the industry, from reading countless books, attending many seminars, and conducting an endless amount of trial and error. The result is a healthy return based on a combination of company analysis, chart monitoring, and, more recently, a reliance on leveraged funds.

Disclosure: Stocks mentioned are one’s owned at various points in time.